The Issues: Economic Crisis

Over the past few months I've participated in extensive debate with many people about this upcoming election. Since my home in Chicago is overwhelmingly liberal, there is no shortage of opponents. I respect and have taken the time to research and carefully consider the opposing viewpoint.

The Economy and current crisis

One of the Media / Democrat's greatest accomplishments this election cycle has been to convince much of the American population that the current economic crisis is the Republicans / Bush's fault. While there are many parties at fault, most Americans have the blame squarely misplaced. We know that GSE's (Freddie and Fannie) have been around since the 60's. However, in 1999 the Clinton administration challenged the GSE's with the social mission of expanding home ownership to minorities and low-income borrowers. At the time the administration believed home ownership should be available to all, regardless of their financial situation. Consider this article, written in 1999. Some key statements:

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer.

In July, the Department of Housing and Urban Development proposed that by the year 2001, 50 percent of Fannie Mae's and Freddie Mac's portfolio be made up of loans to low and moderate-income borrowers. Last year, 44 percent of the loans Fannie Mae purchased were from these groups.

Said Peter Wallison a resident fellow at the American Enterprise Institute. ''If [Freddie and Fannie] fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

Wow..... amazing prognosis from ten years ago.

The plain English explanation is as follows: Ten years ago, there were requirements to obtaining a mortgage, such as having a job, needing to demonstrate income, having a good credit score and putting 20% down. These requirements excluded many low-income people, and a disproportionate percentage of minorities. Instead of thinking about how these groups could starting meeting the requirements, Frannie and Freddie decided to simply lower the requirements.

As you can see from the article above, the level of low-income (aka sub prime) borrowers rose to over 50 percent. However, as recently as last year, the COO of Fannie Mae was saying sub prime mortgages accounted for less than two percent of book value, and that the company was not in any danger!!!

These companies (which as we found out are backed by the credit of the U.S. government) were directed by the government to guarantee mortgages of previously uncreditworthy people. Now, we are finding out that uncreditworthy people can't pay their bills. Surprise!

Mortgage lenders didn't care who they were issuing to, because they could turn around and sell the loan to Fannie/Freddie and transfer the risk completely. Freddie and Fannie were asked by former President Bill Clinton to create standards that low-income people could qualify for - they had no choice. F&F packaged these loans by the thousands, sliced them up and and served them to investors. Many of these mortgage pools were rated as high as AAA by the credit rating agencies - theoretically as safe as a U.S. Treasury bond.

Since more people could buy qualify for mortgages than previously, more people could buy homes. This caused an unnaturally high rise in home values. Check out this chart.

As home values rose, people realized they could take a loan on the supposed equity in their house (not available during previous housing booms). They spent this money instead of saving it. Interest rates rose, ARM's reset, suddenly these sub prime borrowers couldn't make payments. Housing values started to decline, and borrowers couldn't refinance. Foreclosures skyrocketed. The banks and investment firms that held these mortgage pools are now blowing up.

Why do I tell you all this? Because this current crisis can all be traced back to Fannie Mae, Freddie Mac, and the mission instilled in them by former president Clinton to expand home ownership. Those were the operators of this house of cards. In fact John McCain said so in 2006, when he pushed for greater regulation of Freddie/Fannie and warned of the great risk these institutions posed to the taxpayer. Unfortunately, this bill was squashed by the Democrats, who declared at the time "there is no reason to suggest these companies are at any risk".

Contrary to what you hear on TV, I don't believe that the current situation is as a result of de-regulation. Private companies analyze risk and adjust behavior accordingly. Instead, I believe we are in this situation because of regulation. It was regulation that lowered lending standards to the point that we encountered this chain reaction and downward spiral. It was regulation that allowed loan originators to completely transfer risk. And it is regulation that created a private loan corporation that was backed by the funds of the U.S. Treasury!

Check your facts! The Democrats ought to have to own up to this - but nobody is making them...






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